The Unnerving Thing Wells Fargo Just Said About the Auto Boom

American consumers are borrowing like never before to buy cars. It has been the reason why the US auto industry is intoxicated with its own exuberance. Last year, 16.5 million new vehicles were sold. This year, the industry hopes to breach the sound barrier of 17 million, or even 17.5 million. The industry is already dreaming about new all-time highs.

The growth is funded with borrowed money. Total auto loan balances outstanding grew 9.3% year over year to $975 billion at the end of December, an all-time high, according to Equifax. These balances will likely exceed the $1-trillion mark soon.

Auto lending to subprime customers – people with credit scores below 640 – has been particularly booming. Through October last year, 27.4% of all auto loan balances and 31% of the total number of auto loans were to subprime borrowers. Banks and subprime-focused specialty lenders convert these loans into structures securities, many of which carry triple-A ratings. They’re are selling like hot cakes, as bond fund managers gobble them up to create some yield in a world where central banks have expunged yield.

But bank regulators are warning about the auto lending spree. They’re worried about the ballooning loan-to-value ratios where the loan exceeds the “value” of the car by large amounts. Given that a car loses a lot of value the moment it drives off the dealer lot and continues to lose value, high LTV ratios raise the losses for lenders if the car is repossessed. But high LTV ratios also make the car expensive to finance. To keep payments down, loans are stretched to ludicrously long terms. And bank regulators are worried that these risky loans are made precisely to the riskiest customers.

Just last Wednesday, Darrin Benhart, deputy comptroller for supervision risk at the Office of the Comptroller of the Currency, which supervises all national banks and federal savings associations, warned about these auto loans at a conference of the Global Association of Risk Professionals, according to the American Banker. The OCC was already seeing a deterioration in auto loan portfolios, he said.

Timing was somewhat ironic. Equifax had just gotten through praising these loans and denying that there was a subprime auto-loan bubble. It explained that these portfolios had survived the Financial Crisis in better shape than mortgages, and that they would do well in the next crisis. Now Benhart dashed these hopes, it being “unclear if this paradigm will persist in the future.”

And worse: “So far,” he said, the surging auto loan volume and the relatively low payments achieved with these ludicrously long terms are “masking delinquency and loss rates as a percentage of total volume.” And thus, they understate the risks.

He blamed the Fed-engineered low-interest rate environment that was squeezing the margins of these lenders. To goose their profits, they get into strategies and activities without evaluating or understanding the risks they are incurring. And these risks “could contribute to future vulnerability.”

The OCC has been running itself ragged warning about the risks banks are once again taking on, as if they’d never heard of the Financial Crisis. And these banks are understating these risks, it said. Already last June, it had issued a damning report, singling out, among other risks, the no-holds-barred subprime auto lending with extended terms and astronomical loan-to-value ratios.

Now banks are finally responding.

Wells Fargo, which originated $30 billion in auto loans last year, has for the first time put a cap on subprime auto loans, limiting the dollar volume of subprime loan originations to 10% of its total auto loan originations. The New York Times reported that the bank, “according to people briefed on the matter who were not authorized to speak publicly,” has been “increasingly rejecting loans that dealers expected would be approved.”

And Wells Fargo’s subprime cap of 10% of loan volume is setting the tone for the rest of the industry, where the national average has been 27.4%.

Regulators are not only worried about the banks but also about the structured securities auto lending has spawned.

If subprime auto loans go bad in large numbers, as they’re likely to do, the structured securities based on them will take a hit, and investors will get to lick their wounds once again in their chase for yield. Banks and specialized subprime lenders will take a hit too. Megabanks like Wells Fargo might see their earnings get dented, but the amounts aren’t big enough to topple them. Smaller lenders that have specialized in subprime might not be so lucky. But the auto loan subprime bubble, when it implodes, won’t sink the US financial system as a whole; it’s just not big enough.

Yet if these lenders are cutting back on subprime lending in a drastic manner, all heck will break lose in the auto industry.

How are these financially challenged folks going to finance their new cars? Many won’t be able to. The lucky ones will be switched to used cars, and they’ll have to buy something a lot cheaper. It will hit volume, and it will hit dollar sales even harder.

Subprime lending funded about 8 million new and used vehicle sales in 2014, in a universe of 16.4 million new and 42 million used vehicle sales. It has been a powerful force. It has driven auto sales to levels that have made the industry drool. But when that force buckles, it will impact automakers, their suppliers, dealers, railroads, trucking companies, and other sectors. It will ripple through finance companies and insurers. It will hit employment. And it will show up in retail sales.

Unlike Wall Street, the car business has a huge impact on the main-street economy. But a big part is funded with subprime loans, which are now being curtailed. Fasten your seatbelts.

Never mind, I’m an idiot. Serves me right for not reading the *entire* posting.

Gil Obrero

Mar 2, 2015 at 10:01 pm

The New York Times reported that the bank, “according to people briefed on the matter who were not authorized to speak publicly,”

As far as the eye can see looking back at anything the NYT comes out with and its “anonymous” sources, means just one thing.

A false flag, a lie, a corrupt version, propaganda, call it what you will but one for sure, its odds on , heavily so, that it is not the truth of the matter.

Think about it, does anyone really believe that the NYT could not go direct to WF and ask point blank and get an official from a named source response. Of course not were that to be in any way factual.

For my money this is a sop put out by WF to boost flagging sales of its toxic crap to gullible investors and managers.

Its a bank, a highly corrupt bank in the business of fleecing anyone who has a pulse.

So in an effort to boost its toxic sub sewer loans and foist them off on gullible investors what better way than corral another toxic poisonous purveyor of propaganda to your cause.

Vespa P200E

Mar 2, 2015 at 9:45 pm

Wolf,

Good call on auto subprime issue long before others picked it up. The sheeples naive enough to jump right into subprime mortgage they could not afford (even if the banks gave out high interest “liar” loans with anyone with a pulse) got hoodwinked again by the banksters in cahoots with likes of Government Motor who screwed the ex-bond holders like me and rewarded UAW thugs (over bond holders).

Ray

Mar 2, 2015 at 11:18 pm

Also don’t forget that a prime borrower becomes a sub-prime borrower the moment he loses his job.

Luke

Mar 3, 2015 at 7:07 am

Enron, Worldcom, um, it never ends…the crime scene, like 2008 or 2001 or 1987 or LTM or international Banks gett’n defaulted on in the 70’s and, and, it never ends…sub-porn took out the guys….sub prime house? sub prime car? …nobody has a brain. Free vids!

MC

Mar 3, 2015 at 11:54 am

This is nothing.
Car sales in Club Med countries (all and some financed, with Greece being the only notable exception) are booming: basketcase Italy, whose industrial base is disintegrating and whose GDP growth is propped all the way to 0% by an orgy of public spending, saw sales grow by 13.5% year on year in February. March is predicted to be even “better”.
Last year car loans in Club Med countries took off courtesy of Santander, which has been lending to auto-specialized financial outfits with almost reckless abandon. To stay in Italy again the first 2014 semester saw a 26% increase in auto loans.
And this is all debt colonies such as Italy, Spain and France have to show to their credit: an automotive bubble built on far shakier fundations than the last one.

But this time, things are different. 2008 changed everything: auto manufacturers know for sure they will be bailed out. Last time around only Sweden had the moral integrity to let a manufacturer (SAAB) go bust. Everybody else fretted around to “save” this bloated and morally bankrupt sector by the tune of billions. Untold sums were poured into electrics, greatly distorting the market: despite subsidies the BMW i3 electric cost as much as a 3-series wagon at a very nice level of trim, which doesn’t benefit from subsidies. Throw in the auxiliary gasoline engine and we are entering 5-series territory. Great Deformation indeed.
And let’s not even talk about banks: with Draghi at the helm, no sacrifice (of taxpayers and savers) is too big to keep them from throwing hissy fits.

But at least the US can look forward to interest rate hikes in a few months: Yellen needs to call herself out of the currency war. The ECB, by contrast, has fully embraced it. This despite the fact “on this battlefield no one wins”.

NY Geezer

Mar 3, 2015 at 1:54 pm

A credit score of 640 is just another poorly defined financial term like the triple A tranche in which the loans given to persons with such scores are placed.

Because the meaning is vague to me , I envision the score attributed to a person issued a student loan for enrolling in a beautician or computer literacy course of study who declares the proceeds to be income for the purpose of buying an old car that won’t last through the winter.

I can’t imagine why a bank would place a restriction on such quality loans. How can there be any doubt that such a person would faithfully continue to pay that loan first each and every month for the privilege of owning the car.

And, there is no problem if the loan is not paid because the Fed will just buy all the unsold tranches at full value from Wells and the other banks and just extend the existing financial repression that has been imposed on the general population in order to repay itself. Savers had better not expect interest.

Nick Kelly

Mar 3, 2015 at 11:51 pm

I see a way out of what looks like a black hole. The car manufacturers will have to take over and offer direct financing to the growing sub-prime tribe. ( at 66 it looks like I will be going to re-cycling without ever owning a new car. But I’ve owned and own some nice ones- just not new.)
Now the loans will still be sub-prime and the end game will still occur- BUT! It will be a domestic (trust me) manufacturer in trouble not some scummy loan shark and you know what that means!

Dead at 18, buried at 65

Mar 6, 2015 at 12:25 am

Hello Wolf. I would like to know where Channel Stuffing plays a role in all this? Surely, the role of the financiers in the vehicle prime and sub prime industry cannot be the only picture on the state of the auto loan and car industry?

Automakers report as their monthly unit sales only those units that dealers reported as delivered during that month. So the monthly volume figures that we read about are based on dealer sales (OK, dealers play games with it too because they get volume bonuses, etc., but it just eats into next month’s sales and doesn’t impact overall volume.)

Automakers report as “revenue” the amount of money they receive from dealers for vehicles sent to dealers. I don’t remember when exactly a dealer order becomes “revenue.” I think it becomes revenue when the unit is “invoiced” to the dealer. This happens while the unit is still in the plant or on a holding lot somewhere, long before the dealer sees it.

So “Channel stuffing” doesn’t show up in the monthly unit sales figures (since those are dealer sales, when the units exit the channel). It shows up in quarterly dollar revenues that automakers report on their financial statements.

Julian the Apostate

Mar 6, 2015 at 9:47 am

The common theme that runs through all of this malinvestment is the manic pursuit of yield. This situation is set up by ZIRP and NIRP, i.e. government policy. Many commentators here and elsewhere want to assign blame to the ‘greedy capitalist’ side of the equation rather than on the ‘government force’ side. Since when is government – any government – clean and pure as the wind driven snow? CRONY CAPITALISM IS NOT CAPITALISM